Week ahead in the FX market

Last week, Chair Yellen reiterated the data-dependent nature of the liftoff decision and that the Fed is looking for "decisive evidence" on the sustainability of moderate growth, wage increases, and rising inflation. As such, US economic data should continue to be a key driver of the financial markets this week. In particular, personal consumption and core PCE prices are likely most relevant, while other monthly data, including durable goods orders, new home sales, and Michigan consumer sentiment, will also be watched. Ongoing improvement in the data to allow the Fed to begin tightening in September, well before the market expectations, which have now shifted towards a December hike.

USD will likely continue to be supported in the medium-long term, as it is the currency of the country most capable of generating inflation and closest to beginning to normalize monetary policy, next week USD will likely stay range-bound due to a lack of important economic releases. 

The USD should increasingly benefit from superior returns to capital in the medium term, driven partly by a rapidly closing output gap, and safe-haven demand, given the low variance of asset returns. In this sense, Fed rate hikes are simply a validation of the US's superior returns to capital, which should ultimately drive currency appreciation.

Elsewhere, Greek political uncertainty remains the key risk for the markets. As the 18 June Eurogroup meeting ended without any significant progress, euro area heads of states have scheduled an emergency summit for 22 June (Monday) in what could be a last-ditch attempt to strike a deal to avert a financial crisis for Greece. 

With the end-of-June IMF deadline fast approaching, if there is no progress next week, an immediate negative market reaction consistent with a crisis scenario would be likely. As such, the EUR likely remains vulnerable to Greece-related headline risks in the week ahead.

Economic activity data are another focus for the euro area. While the recent improvements in the activity and inflation data are encouraging, analysts wary of downside risk. Indeed, the economic recovery seems to have been unfolding slightly slower than expected, especially in Germany. The upcoming June euro area manufacturing and services PMI will shed more light in this front. However, the relatively large negative output gap in the euro area, which we expect to remain in the coming years, along with the ECB's commitment to the QE program, should suppress the returns to capital in the euro area, weighing on the EUR.